Recovery & Resolution: the operational effects of bail-in
Systemic banks are at various stages in their submission of RRPs to regulators. In the US, tier 1 banks will have already submitted their first plans under Title I of Dodd-Frank, with the other tiers due to submit later in 2013. In the UK, aside from the largest institutions, submission has been delayed multiple times, with a policy statement finally expected this quarter.
Regardless of these shifting timelines and requirements, ops and tech professionals in both jurisdictions will soon have to submit annual data on key operations including staff and their roles, contractual dependencies and outsourcing and data recovery measures.
More than ever, this reinforces the imperative to Know Your Firm. That, however, might soon become more complicated.
Towards the end of last year, the Bank of England signed an agreement with the US Federal Deposit Insurance Corporation that may have a significant effect on the shape of those RRPs already in the works. The agreement was a commitment by both parties pledging to use the bail-in model of bank resolution. To cut a very complicated story short, a bail-in is the opposite of the now infamous bailout, in that it forces shareholders, rather than the taxpayer, to shoulder the bank’s losses. In light of this, operations will need to understand the potential effects of bail-ins on their senior management, HR and contracts.
The most important potential effect of bail-in is that it significantly decreases senior management’s job security in times of financial stress. If things get tough, the regulator takes over the firm as a quasi-administrator, immediately dismisses the senior management and forces the old shareholders out. It then selects its own replacements until the firm is buoyant again, at which point the new shareholders are free to elect a new board. As a result, firms can no longer rely on the same key individuals being present when they are needed most – when the firm is struggling to get back on its feet.
Therefore, as part of their RRPs, professionals will want to consider multiple scenarios where key figures, such as chief operating officers, are removed and replaced with unknown external persons. The results of this will be unique to each firm. But, in all cases, firms will want to make sure that their roles, procedures, responsibilities and organisational charts are well defined and documented so that key staff can be replaced quickly.
Those in the accounting and auditing functions, and those managing them, will also have to consider the effects of bail-in, particularly in relation to where capital is held within the corporate structure. Control of the firm is achieved by a ‘single point of entry’ approach. This simply means taking control of the parent company as opposed to its subsidiaries. And when the regulator seizes the parent company, it also seizes the company’s capital, which it then uses in the process of stabilising the firm, meaning these funds are off-limits during the bail-in. The success of a bail-in will depend on how much capital is at the regulator’s disposal in this way.
However, capital is raised by issuing debt at different levels within the company. Some firms frequently issue debt at the holding company level, while others, especially in the UK, issue it at the subsidiary level. As a result, UK regulators may require more capital to be raised at the parent company level. In either case, firms will have to pay greater attention than ever before to where capital is held within their institution. With the potential for up to 10% of all liabilities to be frozen (according to the EU draft RRP Directive), firms will want to have a clear idea of how they will maintain liquidity throughout the rest of the institution, were the holding company to be seized. This will involve a significant amount of modelling and comprehensive scenario analyses.
Lastly, the agreement may have huge repercussions for legal departments and their budgets. In order to prevent contagion, the bail-in model involves the freezing of contracts, preventing them from being terminated. Not only does this cast doubt over the future of commercial contracts but also over outsourcing, service level agreements, licensing, IP arrangements and beyond, especially where these are in the name of the parent company
Ultimately, in subscribing to bail-in, the UK and US are attempting to set a precedent in the hope that other jurisdictions will follow their lead. But there are clear risks of this regulation fragmenting, with some countries refusing to endorse bail-in, or pursuing differing bilateral agreements altogether. Despite these pitfalls, the facts that bail-in is included in the EU Crisis Management Directive, and is being pursued by the US and UK, are a strong indication that it is set to become a permanent feature of regulatory agendas. Because of this, firms would be well-advised not to delay making the necessary preparations to stay ahead of what comes next.
This agreement means, now more than ever, that it is in firms’ commercial interest to have clear plans for all recovery and resolution eventualities, especially bail-in which otherwise might prove ruinous.